2016 ESTATES AND TRUSTS TAX COMPLIANCE AND POST MORTEM PLANNING — IT’S A NEW WORLD OUT THERE!

AUTHOR: Trevor Smithers, CPA, CMA

Just around the corner a series of new tax rules kick in that will impact the taxation of trusts and estates. These new rules will result in significant changes to existing and future tax planning arrangements. The current rules allow estates, testamentary trusts and grandfathered inter-vivos trusts indefinite access to the same graduated tax rates as an individual taxpayer. This often results in a lower overall tax liability where trust beneficiaries have access to more than one set of graduated rates.

The new rules come into effect January 1, 2016. With the exception of Graduated Rate Estates (GRE) and Qualified Disability Trusts, all testamentary trusts including estates as well as grandfathered inter-vivos trusts will now be taxable at a flat rate equal to the top federal personal tax rate. Additional changes include a mandatory December 31 year-end, quarterly instalment requirements, and no access to the $40,000 AMT exemption. The ability to retain and tax income inside a trust will only be allowed to the extent that losses are realized or carried forward. The loss carry-back provisions of subsection 164(6) of the Income Tax Act, which are widely used to reduce estate taxes, will now be restricted to those estates designated as a GRE. Finally, income and capital gains arising from the deemed disposition of trust assets upon the death of the life tenant of certain life interest trusts will now be included in the income of the deceased individual and taxed in the terminal tax return and not the trust.

Graduated Rate Estates (GRE):

As noted above, these changes will not apply to GRE’s and Qualified Disability Trusts. A GRE is an estate that arose upon the death of an individual. It qualifies as a GRE if no more than 36 months has passed since the date of death. The GRE is considered a testamentary trust for tax purposes. These trusts will have access to graduated tax rates, a $40,000 AMT exemption, and will not have to pay tax instalments for the period it remains as a GRE. If the estate is not wound up within 36 months of death, it loses its GRE status at which point the estate will then be taxed at the top marginal tax rate. Only an estate can qualify as a GRE and it must be designated as such in its first post 2015 year-end income tax filing.

Items to Consider:

Trustees will have some additional compliance requirements resulting from the new rules. As noted above, new and existing GREs will need to be designated as such in the first T3 Trust tax filing after December 31, 2015. While GREs will be able to file using a non-calendar year end, non-GREs and other testamentary trusts having non-calendar year-ends will be required to file a stub period tax filing in order to comply with the mandatory calendar year-end.

In circumstances where individuals may have set up multiple wills with differing executors and residual beneficiaries, it will be important to review the wills to ensure that the desired tax planning objectives can still be achieved with the ability to name only one estate as a GRE.

Going forward, will planning resulting in multiple testamentary trusts being created strictly to access the graduated tax rates will no longer be possible. However a discretionary testamentary trust that is used as an income splitting device still has merits. Furthermore, testamentary trusts still offer a number of non-tax benefits, such as independent control and management over the capital from beneficiaries who may be minors or spend thrifts, or possibly to shield trust assets from the beneficiary creditors.

Life Interest Trusts will be impacted by the new changes. Take for example a spousal trust where the life interest beneficiary (the surviving spouse) has subsequently remarried. Under the old rules, the spousal trust was deemed to have disposed of its’ property upon the death of the surviving spouse and the resulting capital gain was taxed inside the spousal trust. The spousal trust would pay the tax and the net assets distributed to the residual beneficiaries, typically being the children from the first marriage. Under the new rules, the deemed capital gain will now be taxed in the deceased individual’s estate. The assets that could be liquidated to pay the deceased’s tax liability are still in the spousal trust. The spousal trust cannot pay the tax of the life beneficiary since this would taint that estate and its GRE status. Difficulties could arise where the spousal trust and deceased estate’s residual beneficiaries are not the same parties.

Also, effective January 1, 2016, there are new donation rules for gifts made by will which will provide greater flexibility to the executors in terms of the timing and location of the claim. For non-GREs charitable donations can only be claimed in the first five years of the estate whereas GREs have several different options for claiming the donation including taking the credit as part of the terminal tax filing. Also, only a GRE can take advantage of the zero capital gains inclusion rate for an in-kind donation. All non-GREs will be taxed on the capital gain that arises from the disposition of the in-kind asset.

In light of these significant changes we recommend that you revisit your wills to determine their impact with your current tax planning arrangements. Please don’t hesitate to contact your McCay Duff representative to discuss your particular situation in further detail.